This article, from law firm McGuireWoods LLP, is authored by Steven Keeler and Clare Lewis.
Over the last decade, venture capital and private equity news sources have emphasized the short-term and often extreme swings in clean tech as an investment sector. Quarterly and annual investment trends analyses have been inconsistent and, at times (and 2013 and Q1 2014 are no exception), hard to explain. As a result, many investors (other than clean tech specialists, family offices and large funds, and institutions investing in renewables projects or discrete subsectors of clean tech) have pulled back from clean tech investing. But a closer look at this evolving sector reveals that investors have refined their investing styles and migrated to and from various subsectors of clean tech as those subsectors have evolved.
Certain investors are seeking good yields from project finance and more debt-like plays, which others are employing old-style private equity discipline to find good clean tech companies with strong management teams and large addressable markets. And each of these groups plays off the other – project finance has been stronger than VC and PE investment in companies of late, but the resulting projects and renewables manufacturers could ultimately become buyers from companies operating in the development, energy optimization and resource solutions. The maturation of renewables and migration of capital to less mature clean tech subsectors (all despite strong economic and policy headwinds) reveals that, similar to health care’s evolution as an investment sector, clean tech is converging with the overall economy and is here to stay.
To analyze clean tech’s past performance, current state and future prospects, we think it is important to take Cambridge Associates LLC’s lead and divide clean tech into several subsectors – such as (1) renewables manufacturing, (2) renewables development, (3) energy optimization and (4) resource solutions. We also think it’s critical to divide clean tech investing between project finance of power and fuel projects and facilities, on the one hand, and venture capital and private equity investment in companies providing clean tech solutions or energy-related services. Finally, beware of clean tech news sources and headlines which may make broad statements about clean tech investment but, upon a closer read, are only covering renewables or a few subsectors, or private equity or venture capital (and not project finance or corporate investment). A long-term assessment of clean tech and the companies that operate within it demands a recognition that this sector is broad, economically convergent and, at the end of the day, a collection of energy projects and companies providing strikingly different risk and reward profiles.
Ups and downs in a relatively young investment sector are to be expected and eventually make its maturation and long term potential possible. As with health care (including its service provider, pharmaceutical, medical device and IT subsectors), clean tech is an extremely broad universe of solutions and companies covering all stages of development and the entire energy and environmental solutions spectrum, and, thanks to consumer demand, corporate mandates and government policies, it is rapidly becoming integrated with the overall economy. A closer look at clean tech’s evolution and the migration of capital to and from its different sectors reveals that, despite the growing pains and lost investments that typically accompany the growth of a major investment sector, investors appear resilient and committed to finding ways to capitalize on the longer-term opportunities within clean tech.
“Clean Tech”: One Subsector, and Company, at a Time
Venture capital and growth equity have flowed to renewables developers and companies providing energy efficiency and resource management solutions, while large private equity, pension funds and other institutional players have focused on project finance and energy facilities. Most of the venture and private equity investment deals over the last decade have been early stage, but most of the money has gone to later stage companies with less risky return prospects. Improved alignment of different types of investors with strikingly different types of clean tech investing, coupled with historical data that confirms wind, solar and biofuels have grown up, renewables development may provide superior and quicker returns (as compared to producers and manufacturers), and demand-side solutions (energy efficiency and sustainability) and energy services providers and vendors (particularly in light of the gas boom in the U.S.) may present the best opportunities for venture capital and private equity funds to participate in clean tech in the next five to ten years as economic, tax and policy issues continue to be sorted out (or not).
Cambridge Associates LLC’s 2013 Clean Tech Company Performance Statistics evaluated company-level performance instead of the fund-focused capital raising and deployment and exit statistics more commonly published by other information sources. Their report expressed the view that more traditional quarterly and annual VC and PE reports may not provide investors with adequate information to make informed choices within clean tech investing. We agree, and some interesting things jumped out at us from this report:
- VC dominance. Of the 452 funds from which the Cambridge report drew, 327 were venture capital funds and only 125 were private equity funds. One cannot help but think of the dominance of VC in life science investing. Angel, family office and VC fund investors are funding clean tech research and development, entrepreneurs and companies. These investors have to some extent moved away from renewables (the supply side and projects) to energy optimization and resource management (the demand side and companies).
- Sector development. Cambridge divided clean tech companies into four sectors: (a) renewable power manufacturing, (b) renewable power development, (c) energy optimization and resource solutions. Renewable energy development barely beat out manufacturing in total capital raised, with energy optimization comfortably taking third and the broader, and still evolving, resource solutions sector taking a distant fourth. The numbers confirm that renewable power production has matured and is best for investors looking for predictable yields, renewables development is now producing higher IRRs than ownership, energy efficiency and storage are slowly growing up, and resource solutions (for example, water) are in their infancy. We have previously referred to this as the “maturation” of the supply side and “migration” of venture and growth private equity capital to the demand side, and we believe this explains the current positive trends for project finance and negative news on VC and PE investment in clean tech. At present, renewables development and energy optimization boast the highest returns, with renewables production having matured and resource solutions still coming of age.
- Clean tech is so young and the capital has continued to flow. 94% of the capital deployed in clean tech has been invested in companies that received their initial funding in or after 2005.
- U.S. – Big capital, small returns. U.S.-based companies have received 74% of the capital invested in clean tech but returns on these investments have been much lower than non-U.S. clean tech investment returns. This may confirm two things: U.S. climate change policies have trailed that of other countries, but investors continue to see the U.S. as the best place to make clean tech bets in the long term. And this could be due to the prevalence of renewables projects overseas and the dominance of U.S.-born technology companies.
- It’s the economy stupid. Clean tech investment peaked in 2008 and the amount of first-time capital in new clean tech companies has since declined. However, total investment from 2008-2012 has outpaced 2000-2007, demonstrating that the economy, government policies and poor initial returns have not stopped the flow of capital to clean tech.
“Clean Tech”: Project finance and vc/pe can be counter-cyclical, but the former needs the latter
Blue and Green Tomorrow (http://blueandgreentomorrow.com/2014/04/14/clean-energy-investment-up-14-in-first-quarter) reports that “clean energy investment” was up 14% in Q1 2014 over Q1 2013. So, this refers to all financing of renewables. Indeed, this uptick was comprised mostly of project finance bets on offshore wind. Venture capital and private equity investment actually fell year-over-year. And total investment in renewable power actually fell for the second year in 2013 (although Bloomberg Energy Finance credits reduced solar system costs for this). Confused yet?
Once again, wrong conclusions can be drawn from the clean tech headlines – at least regarding the long-term prospects for clean tech. Project and debt finance in clean energy projects has increased for four consecutive quarters. But venture capital and private “equity” investment in clean tech companies trended down in Q1 2014. This, despite a 10-quarter peak in solar investment by venture capital funds (i.e., in companies, versus utility-scale projects, reflecting the move to distributed solar). Clean Energy Pipeline, “A promising start to new clean energy investment in 2014). These subsector and capital markets cycles can be viewed as a natural and even positive part of an evolving and maturing investment class. Investors have begun to find the right subsectors and securities for them, and the money has begun to find the right markets.
According to Bloomberg New Energy Finance (Global Trends in Renewable Energy Investment 2014), VC and PE investments in specialist renewable energy companies or their vendors plummeted in 2013 to its lowest level since 2005. The explanation was classic (and perhaps true): funds took a cautious view of young high-technology enterprises. Contrast this with the performance of the public markets for renewable energy in 2013. Institutional investors wanted less risky yields on portfolios of operating projects. Pension funds and even family offices are increasing their investment in wind and solar projects. Bloomberg’s report only included renewable energy production, so a less careful read of their headlines would miss the reality that VC and PE investment in developers, energy efficiency and resource solutions was a different story.
To be sure, the public-market embrace of renewables and cost reductions in solar are just the most recent evidence that renewable energy is maturing and thriving. This alone makes clean tech an investment sector that is here to stay, as clean tech solutions and energy service providers will have a larger market for their products and services. However, it is equally true that VC and PE investors (as they did in the life science arena) will have to analyze and pick the most promising clean tech sectors based not only on their stage of technological and market development but the performance and prospects of the companies operating in those sectors. VC and PE funds know how to find capital-light business models and well-managed companies. This focus and ability should enable smart and patient investors to avoid the clean tech hype and achieve attractive returns from investments in real companies with good management and large addressable markets. Sound familiar?